Question

In: Finance

1. A project costs $10 million today. Next year (year 1) the cash inflow will be...

1. A project costs $10 million today. Next year (year 1) the cash inflow will be either $10 million or $2 million with equal probability. If the year-1 cash inflow was $10 million, then the year-2 cash flow will also be $10 million. If the year-1 cash inflow was $2 million, then the year-2 cash flow will also be $2 million. If the firm can abandon the project ONLY after year 1 for a known amount of $3 million at that time, what is the abandonment value if the appropriate discount rate is 5%?

$157,000
$260,000
$521,000
$1,157,000

2. Project 1, that the firm is already doing, currently has an expected NPV of $120,000 and a standard deviation of $200,000. Project 2, that the firm is going to undertake, has an expected NPV of $100,000 and a standard deviation of $150,000. The correlation between these two projects is 0.80. What is the coefficient of variation for the portfolio of projects?

1.67
1.59
1.51

1.27

3. You have just agreed to a new loan and have purchased a $3,000 computer today. The loan has a 19.6% annual interest rate, compounded monthly. The minimum monthly payment is $58 and you do not expect to ever pay more than the minimum payment. Assuming no additional charges or costs will occur with this loan, approximately what will you owe on the loan at the end of 3 years (36 months) when you expect to need another new computer?

$2,676
$2,564
$2,304
$2,088

Solutions

Expert Solution

Answer>

I am providing answers to the first listed question - that is, question 1.

Abandonment value = Value that would be generated by liquidating the project if it is not profitable or its NPV if the project is profitable.

Present value (PV) of cashflow in nth year is given by:

PV = CF / (1+r)^n,

Where,

r = discount rate = 5%

n = year

CF = cash flow

Also,

NPV = PV of cash out flows - PV of cash inflows

Abandonment Value = PV of all cash inflows when liquidated

Here

Total cash outflows = 10000000 ---- invested in 0th year

PV of cash out flows = 10000000

Now, Cash flow in the 1st year"

10000000 with 50% probablity

2000000 with 50% probablity

Hence expected cash flow in the first year = 50%*10000000 + 50%*2000000 = 6000000

PV of the expected cash inflow in the first year = 6000000/(1+0.05)^1 = 6000000/1.05 = 5714285.71

Cash flow in the 2nd year

10000000 with 50% probablity

2000000 with 50% probablity

Hence expected cash flow in the first year = 50%*10000000 + 50%*2000000 = 6000000

PV of the expected cash inflow in the second year = 6000000/(1+0.05)^2 = 6000000/(1.05)^2 = 5442176.87

Total PV of cash inflow = 5714285.71 + 5442176.87 = 11156462.58

Hence NPV of the project = 11156462.58 - 10000000 = 1156462.58

Since the NPV is positive, the abandonment value of the project is 1156462.58 = 1157000 --- option d

Hence the correct answer is option d


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